What does COP26 mean for the Financial Services sector?

Thought Leadership

Rasmus Christensen – 30 November 2021

Now that the dust has settled from COP26 it is a useful time to analyse the outcomes and potential impact for the Financial Services sector.

What was COP26?

The Conference of Parties (COP) is an annual summit through which world leaders gather to discuss the effects of climate change, measure progress on climate related targets and agree to new goals.

Significant COP outcomes include the Kyoto Protocol (COP3) which committed signatories to measuring and limiting the emission of greenhouse gases. In 2015 at COP21, the Paris agreement was established with Article 2 outlining the goal of keeping global temperature rises to well below 2C and aiming for 1.5C of pre-industrial levels. As a result, each country is required to submit a plan through which they would help achieve this target, also called an NDC (Nationally Determined Contribution). Every 5 years, nations are to report on progress of their NDC and come together to make new pledges to ensure these targets are reached. COP26 was this checkpoint and coming together of leaders, also called the World Leaders Summit.

What does this mean for the Financial Services sector?

In line with the Paris Climate Accord and the EU Green Deal, the European Climate Law was enacted earlier this year. This legislation is aimed at pointing member countries in the direction to the 2050 net zero goal without legislating for or against any particular activity.

In 2022 the ECB will carry out its first stress test on climate risks, 16 other central banks have committed to doing the same.  The ECB describes this stress test as a learning exercise to enhance the capacity of both banks and supervisors to assess climate risk, whilst also identifying what climate-related data banks currently have available and what data gaps pose limitations for assessing climate-related risks (ECB, 2021). Whilst this stress test will not result in additional capital requirements, it may impact Pillar 2 SREP (Supervisory Review and Evaluation Process) scores.

The UK has enacted legislation requiring all large financial institutions and listed companies to create net zero transition plans by 2023, reporting in line with the TCFD (Taskforce on Climate related Financial Disclosures) framework. Banks including HSBC and Barclays, both founding members of TCFD have been preparing specific TCFD aligned reporting for a number of years.

In the US, the SEC is clamping down on climate-related disclosures, establishing a taskforce focused on ESG misconduct. This is aimed at identifying gaps or misstatements in climate risk disclosures and decreasing the prevalence of greenwashing.

In other words, poor performers beware, climate risks are increasingly viewed as financial risk, not just from an investor perspective, but a regulatory one. Financial Institutions will require deeper insight into their climate impact both direct and indirect as well as modelling on financial impact of various climate scenarios. Understanding and rectifying knowledge gaps should be a high priority given this regulatory scrutiny.

Good news on COP26 Finance Day

Wednesday November 3rd was COP26 Finance Day and it provided plenty in the way of incentive for those seeking to increase green credentials. GFANZ (Glasgow Financial Alliance for Net Zero) an alliance of financial institutions, committed to delivering $130tn of private investment to transform the economy to net zero. These investments will require accreditation from Race to Zero, integrating science-based guidelines in achieving these goals. Adding to this was the announcement that IFRS has established the International Sustainability Standards Board (ISSB) to develop sustainability reporting standards for financial markets. Global standards are significant step in increasing transparency of climate risk and reward, crucial for the efficient allocation of capital.

There were other important wins at COP26 including finalizing the Paris rulebook, the missing piece from 6 years earlier. This helps turn ambition into aligned action. Claribelle Poujol, Project Lead of Digital Platforms for Climate Change Events at the UNFCCC shared her thoughts with Projective on the outcomes from COP26;

“In the area of Climate Finance, developed countries fell short of the $100 billion a year goal by 2020 and through 2025 to support climate efforts in developing countries. At COP26, countries agreed to a robust process to develop a new, larger climate finance goal to go into effect after 2025. An important win at COP26 is the agreement of developed countries to at least double the funding for adaptation by 2025, which would amount to at least $40 billion. This is a significant milestone to address the growing need to adapt to the increasing impacts of the climate crisis already felt by the most vulnerable.“ 

Though COP26 has been widely seen as not delivering enough, it has continued the momentum toward greater transparency and the embedding of climate risk in operating models demanded by investors globally. Moreover, COP26 helped give voice to indigenous people and their climate plight. As custodians of over 80% of the world’s biodiversity, this is perhaps COP26s most important contribution.